2023-05-18 01:37:53 ET
Summary
- ET and WES are both investment-grade, high-yield midstream businesses.
- We compare ET and WES side-by-side after reporting Q1 results.
- We offer our take on which one is the better buy right now.
Energy Transfer ( ET ) and Western Midstream Partners ( WES ) are both investment grade, high yield midstream businesses. In this article, we compare ET and WES side-by-side after reporting their Q1 results and then offer our take on which one is the better buy right now.
ET Q1 Results
ET recently reported Q1 results that were quite strong.
The balance sheet continued to strengthen, with leverage likely to remain towards the lower end of management's long-term 4-4.5x target range. In Q1 alone, they paid down ~$1 billion of debt and have over $3 billion in liquidity. As a result, ET is looking increasingly likely to earn a credit rating upgrade from BBB- to BBB, with management stating on the Q1 earnings call:
Our goal is to get to that BBB flat... We think that BBB is a good place to be and that's what we're going to continue to target.
ET also signaled that it plans to continue spending fairly aggressively on growth projects, with a 2023 growth CapEx budget of ~$2 billion that is primarily focused on its midstream, NGL, refined products, and interstate pipeline assets. With only 10% being invested in crude oil, we expect this portion of their business to decline on a relative basis moving forward.
One meaningful question mark for the business remains the Lake Charles project, as it has hit a bureaucratic/political snare at the Department of Energy. If ET can eventually see this project through to activation, it could lead to substantial cash flow in the future.
WES Q1 Results
WES also recently reported its Q1 FY 2023 results. Highlights included:
WES achieved investment grade status at Moody's during the quarter and also took several steps to push out debt maturities and increase liquidity. The leverage ratio stood at 3.2x, in-line with management's end-of-year target level.
WES also declared a substantial enhanced distribution that will be paid to unitholders later this month while still repurchasing ~$7 million of units during the quarter. While this was a meaningful deceleration in the cadence of unit repurchases, management reiterated on the earnings call that unit repurchases will be executed on an opportunistic basis and that there are fewer opportunities to do so during Q1.
WES also meaningfully lengthened its contract terms with Occidental Petroleum ( OXY ) (in which Warren Buffett's Berkshire Hathaway ( BRK.A )( BRK.B ) holds a large stake), giving it a substantial cash flow runway.
Overall, it was another steady-as-she-goes quarter for WES and the company remains on track to achieve its full-year guidance and leverage target while simultaneously returning significant amounts of capital to unitholders.
ET Stock Vs. WES Stock: Business Models
WES is primarily focused on the gathering, processing, and transportation of natural gas and natural gas liquids across various regions including Texas, New Mexico, the Rocky Mountains, and North-central Pennsylvania.
WES Asset Portfolio (Investor Presentation)
The company's cash flows primarily come from fee-based contracts, which provides stability in the face of volatile energy commodity prices. Moreover, the lengthy nature of these contracts gives WES substantial cash flow visibility well into the future, enabling it to plan investment projects as well as return cash to unitholders with a degree of confidence.
WES's best assets are located in the Delaware Basin, where the company holds a competitive advantage as the sole low-emission oil gatherer, one of three-stream midstream providers, the second largest firm in water gathering and disposal, and the third largest in gas processing capacity.
Energy Transfer, meanwhile, is one of the largest and best-diversified midstream businesses. It owns a strong natural gas infrastructure network, focused primarily in Texas and the central United States.
ET Asset Portfolio (Investor Presentation)
The business is fully integrated from the wellhead to water services and enjoys massive scale. The company is able to:
- Gather ~19.4 million Mmbtu/d of gas
- Produce 813,000 Bbls/d of NGLs
- Transport ~30.1 million Mmbtu/d of natural gas via inter and intrastate pipelines
- Fractionate ~960 thousand Bbls/d of NGLs
- Transport ~4.3 million Bbls/d of crude oil
- Export ~1.1 million Bbls/d of crude oil and 1.1 million+ Bbls/d of NGLs
Like WES, the vast majority of its cash flow comes from fee-based commodity-price resistant contracts. In fact, 90% of its expected 2023 adjusted EBITDA is supposed to come from fee-based contracts. Moreover, its diversified sources of that adjusted EBITDA are quite impressive:
ET Income Sources (Investor Presentation)
Overall, we give the edge to ET here given that it is very well diversified by counterparty and asset geography/type, whereas WES is much more concentrated in both areas, with substantial dependence on its relationship with Occidental Petroleum.
ET Stock Vs. WES Stock: Valuations
When it comes to valuation, both businesses look quite undervalued with attractive total return profiles. ET trades at a meager 5.1x price to distributable cash flow ratio whereas WES trades at a nearly as attractive 6.2x price to distributable cash flow ratio.
From an EV/EBITDA perspective, ET trades at a 7.49x multiple and WES is only slightly more expensive at 7.81x.
From a distribution yield perspective (when accounting for expectations regarding WES' enhanced distribution) ET's forward yield is 10% whereas WES' is 9%. That said, WES is buying back units quite aggressively in contrast to ET which is not buying back units at all right now. As a result, WES' total capital return yield is likely going to be meaningfully higher than ET's over the next twelve months. This is because ET is spending more on capital expenditures than WES is.
Overall, both businesses look quite cheap, though we rate WES as being slightly cheaper given that its five-year average EV/EBITDA ratio is much higher than ET's (11.95x compared to 8.61x) and its free cash flow and total capital return yields are superior to ET's.
ET Stock Vs. WES Stock: Investor Takeaway
Overall, we like both businesses as they have solid balance sheets and stable cash flow profiles. ET is a much better core holding candidate given its vastly superior size and diversification. Moreover, its regular distribution yield is higher than WES' is and management also plans to continue growing that regular payout with some regularity moving forward. In contrast, WES plans to keep its quarterly distribution intact and opportunistically pay out an end-of-year enhanced distribution alongside opportunistic unit repurchases to add on to the regular distribution.
We hold both in our Core Portfolio at High Yield Investor, and rate both as attractive Buys right now that should deliver mid-teens total annualized returns over the next half decade through a combination of high distribution yields, low to mid single digit annualized cash flow per unit growth, and likely some multiple expansion.
For further details see:
Better High Yield Buy After Q1: Energy Transfer Vs. Western Midstream